Evening Market Update

S&P Outlook Downgrade Jolts Investors

US equities finished solidly blow the flatline to start the holiday-shortened week on a sour note after Standard & Poor’s downgraded the credit rating outlook of the US. Also sapping sentiment, China increased its banking reserve requirement for the fourth time this year, and uneasiness toward the debt crisis in Europe persisted. Meanwhile, earnings season continues to move forward, with Citigroup besting the Street’s profit expectations, but falling short on its revenues, while Eli Lilly & Co exceeded both revenue and profit projections. Elsewhere on the equity front, Community Health Systems changed its $3.3 billion bid to acquire Tenet Healthcare to an all-cash offer. Treasuries finished higher following the S&P downgrade, while showing little reaction to an unexpected drop in homebuilder sentiment, and crude oil fell after Saudi Arabia’s oil minister said the global market is “oversupplied” and the Middle Eastern nation cut output.

The Dow Jones Industrial Average lost 140 points (1.1%) to 12,202, the S&P 500 Index was 15 points (1.1%) lower at 1,305, and the Nasdaq Composite declined 29 points (1.1%) to 2,735. In moderate volume, 1.0 billion shares were traded on the NYSE and 1.8 billion shares changed hands on the Nasdaq. WTI crude oil fell $2.54 to $107.12 per barrel, wholesale gasoline was $0.04 lower at $3.25 per gallon, and the Bloomberg gold spot price increased $9.45 to $1,496.33 per ounce. Elsewhere, the Dollar Index—a comparison of the US dollar to six major world currencies— was 0.9% higher at 75.49.

Citigroup Inc. (C $4) reported 1Q EPS of $0.10, one penny above the consensus estimate of analysts surveyed by Reuters, but revenues declined 22% year-over-year (y/y) to $19.7 billion, compared to the $20.5 billion that the Street forecasted. The company said net credit losses declined 25% y/y—having fallen for seven-straight quarters—and it released $3.3 billion in loan-loss reserves. Shares traded to the upside after overcoming some morning weakness.

Elsewhere, Eli Lilly & Co. (LLY $36) reported 1Q EPS ex-items of $1.24, above the $1.17 that analysts anticipated, with revenues increasing 6% y/y to $5.8 billion, exceeding the $5.7 billion that the Street was looking for. The drugmaker said growth in international markets and the strong performance of Cymbalta, Alimta and its animal health business drove revenue growth, despite a significant decline in Gemzar sales due to generic competition. LLY reaffirmed its full-year earnings outlook but raised its revenue guidance, even as it still expects the impact of US health care reform to lower 2011 revenue by $400-500 million. The company said its revenue guidance assumes the company maintains its patent exclusivity for US sales of its drug Strattera, and “severe erosion” of global Zyprexa sales after patent expirations this year and “continued severe erosion” of US Gemzar sales. LLY traded lower.

In M&A news, Community Health Systems Inc. (CYH $31) announced that it is now offering $6.00 per share in cash, or about $3.3 billion, to acquire all outstanding shares of Tenet Healthcare Corp. (THC $6). CYH had originally offered $5.00 per share in cash and $1.00 per share in CYH common stock. CYH said converting its offer to all cash underscores its commitment to completing this transaction and renders THC’s irresponsible and inaccurate lawsuit irrelevant to its offer. Last week, THC filed a lawsuit against CYH, accusing the hospital operator of overbilling Medicare, and CYH said it is confident that its business practices are appropriate and it will respond in detail to THC’s claims in due course. THC said it has received the revised proposal and it will review the offer, pointing out that the new proposal is the same price as the previous cash and stock offer, which THC had determined “grossly undervalued” the company. CYH and THC were both lower.

S&P downgrades US debt outlook, while homebuilder sentiment unexpectedly declined

The economic calendar was relatively light to begin the Good Friday Holiday shortened week, but Standard & Poor’s downgraded its credit rating outlook on the US from stable to negative, due to uncertainty the US will agree on addressing its deficit challenges. S&P said, “We believe there is a material risk that US policy makers might not reach an agreement on how to address medium-and-long-term budgetary challenges by 2013.” The ratings agency added that, “If an agreement is not reached and meaningful implementation does not begin by then, this would in our view render the US fiscal profile meaningfully weaker than that of peer AAA sovereigns.” However, S&P did reaffirm the US AAA credit rating.

Meanwhile, the NAHB Housing Market Index, a gauge of homebuilder sentiment, unexpectedly fell, declining to 16 in April from 17 in March, with any reading below 50 indicating more respondents feel conditions are poor. The index surprisingly declined as present sales and future sales components both declined, offsetting a slight improvement in the response toward prospective buyers’ traffic.

Treasuries finished higher following the downgraded US debt rating outlook by S&P, while showing little reaction to the homebuilder sentiment report, with the yields on the 2-year and 10-year notes falling 4 bps to 0.67% and 3.38%, respectively, while the 30-year bond yield fell 2 bps to 4.45%.

Debt and interest rate hike concerns plague Europe

Debt and monetary policy concerns overseas were exacerbated by the S&P credit outlook downgrade of the US. Sentiment was also soured by the prospect of further interest rate hikes by the European Central Bank (ECB) and continued uncertainty regarding a possible debt restructuring by troubled peripheral euro-area nation Greece. Comments over the weekend fostered some of the uneasiness, with an Austrian ECB council member saying that expectations of 50 basis points in additional increases to the ECB’s benchmark interest rate are “well-founded,” and a Belgium member saying monetary “conditions are too accommodative,” per Bloomberg. Meanwhile, debt concerns remained as the Wall Street Journal reported that the International Monetary Fund (IMF) sees Greece’s debt as unsustainable and the government should consider restructuring as early as next year, according to people familiar with the matter. However, Greece’s finance minister said the nation has no plan for debt restructuring, according to Bloomberg. The only item on the economic docket across the pond was a read on UK home prices that showed an increase for April.

In Asia, China announced that it will raise its reserve requirement ratio—the amount of cash banks have to keep in reserve instead deploying it into the financial system—for the fourth time this year. The ratio will be lifted by 0.5% to 20.5% for the nation’s largest banks, as China tries to limit the liquidity in the financial system to attempt to cool inflation and the formation of asset bubbles. China’s central bank governor said monetary tightening will continue for “some time,” and he said he sees no “absolute” limit on how high reserve requirements can go, per Bloomberg. The nation also raised its benchmark interest rates earlier this month for the fourth time since the financial crisis.

Housing remains in focus tomorrow

Today’s homebuilder sentiment data was the first report of several on the housing market, with tomorrow bringing the releases of housing starts, expected to rise 8.6% month-over-month (m/m) in March to an annual rate of 520,000 units, and building permits, one of the leading indicators tracked by the Conference Board as it is a gauge of future construction, forecasted to increase a modest 1.1% m/m to 540,000 units.

Last month’s housing data was particularly gloomy, with single-family permits and new home sales falling to new record lows and prices of existing home sales falling to the lowest level since April of 2002. However, there have been regional pockets of strength, housing affordability remains high, and job growth is a key factor to ongoing demand.

Internationally, the economic calendar will include: manufacturing and services PMI reports from France, Germany and the euro-zone, consumer sentiment in Japan, and Hong Kong’s unemployment rate. Back in North America, Canada will release CPI, wholesale sales and its leading index.